BA213IU - Ms.

Ngoc Anh

A QUICK GLANCE BACK…

LECTURE 8 What roles Directors play?

EVALUATING EXECUTIVE DIRECTORS’
PERFORMANCE AND EXECUTIVE What are the legal duties of Directors?
COMPENSATION

Lecturer: Phan Ngoc Anh, MBA.

SOME EXAMPLES OF ROLES PLAYED THE LEGAL DUTIES OF DIRECTORS…

BY DIRECTORS…
Bringing wider business and board experience to Duty of trust (fiduciary duty)
the identification, discussion, and decision To exercise a fiduciary responsibility to
making of matters the shareholders
Adding specialist knowledge, skills, and know- To act with integrity, behaving honestly
how and fairly for the benefit of shareholders
Connecting the board to networks of useful equally, recognizing the interests of
people minority shareholders
Providing independent judgement Duty of care
Being a monitor of executive activities To exercise reasonable care, diligence,
Playing the role of watchdog and skill

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BA213IU - Ms. Ngoc Anh

In 1996, Sunbeam, a US appliance manufacturer, was in serious

financial trouble. AI Dunlap, known as “Chainsaw AI” for his
approach to cutting staff, was appointed to save the company.
Over the next 2 years, the business reported dramatically improved
results. Investors chased after the shares as prices rocketed. There
was talk of a bid, which would make the investors, Dunlap, and his
colleagues, a lot of $$$. But no bid came.
Did the Board of Directors
fulfill their duties? If not,
As a result, some outside directors were uneasy and launched an what did they violate?
inquiry. They did not like what they found and Mr. Dunlap was fired. Could such a situation
The SEC then charged him, and other senior executives, and the have been avoided?
audit partner at Arthur Andersen, who had approved the
accounts, with fraud.

Reports revealed that Mr. Dunlap shipped out more goods through
his distribution channels then they could possibly sell, taking credit
for the revenues, but pushing forward the problem to the next year.
Returned goods were overlooked. Other efforts were made to
boost sales artificially: a record number of outdoor barbecues were
sold during the winter months.

EVALUATING EXECUTIVE EXECUTIVE PERFORMANCE

DIRECTORS’ PERFORMANCE EVALUATION
AND DETERMINING EXECUTIVE
COMPENSATION

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BA213IU - Ms. Ngoc Anh

A GENERIC CEO EVALUATION CYCLE

OECD PRINCIPLES
The board should fulfill certain key functions, including:

“Monitoring implementation and corporate

performance; and overseeing major capital
expenditures, acquisitions and divestitures…

“Selecting, compensating, monitoring, and, when

necessary, replacing key executives and overseeing
succession planning….

“Aligning key executive and board remuneration

with the longer term interests of the company and its
shareholders.”

EXECUTIVE EVALUATION – why

needed? DISCUSSION QUESTION

Align the strategic direction set by the board What questions should directors ask in
with the CEO’s capabilities order to evaluate CEO performance?
Promote better board and CEO relations
Allow boards to have greater objectivity about
CEO remuneration
Promote accountability – performance
management being core culture of the
organization
Encourage CEO’s personal development

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BA213IU - Ms. Ngoc Anh

CEO EVALUATION QUESTIONS

Has the CEO:

1. Been responsible for the company’s consistent achievement

of its corporate goals, objectives?
2. Been responsible for the company’s consistent internal EXECUTIVE
culture, policies?
3. Developed, motivated, and retained a strong top
management team?
COMPENSATION
4. Made certain that the company’s capital resources are
sufficient, properly allocated?
5. Provided a positive internal and external leadership role for
employees, customers, shareowners, suppliers?
6. Assured that the company implements a long-term strategy
that maximizes opportunities and considers risks?

CEO’s key challenges ahead?

Major opportunities for further improvement by the CEO?

OECD PRINCIPLES REMUNERATION BEST PRACTICE

The board should fulfill certain key functions,
including:
“Monitoring implementation and corporate Determined by the board and completely
performance; and overseeing major capital disclosed to shareowners
expenditures, acquisitions and divestitures…
Aligned with the long-term interests of
shareowners
“Selecting, compensating, monitoring, and,
when necessary, replacing key executives and Used to motivate executive behavior
overseeing succession planning….
Adequate for executive’ time, effort
“Aligning key executive and board
remuneration with the longer term interests of
the company and its shareholders.”

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BA213IU - Ms. Ngoc Anh

MANAGEMENT THEORIES RELATED

REMUNERATION FACTORS TO COMPENSATION
Theory Main assumption Practical implications for CEO
compensation
Company’s financial performance
Agency theory Left unchecked, CEO may make Board must craft an incentive
Achievement of strategic and operational moves that increase their plan that creates strong
goals compensation but that harm their incentives for CEO to act in
firms the firm’s best interest at all
Scope of responsibilities of the executive times
Social People assess their situation Benchmark a CEO’s
Personal skills, other characteristics of the Comparison relative to their peers’ situation performance and
executive Theory compensation relative to that
of very high performing CEOs
Typical levels of remuneration in the company in the industry
Equity Theory People act to restore balance if Workers may reduce their
and the industry their ratio of effort given to pay efforts if they view the CEO as
received differs from others’ ratios overpaid
 Boards need to diagnose
and respond to CEOs’
feelings about equity

MANAGEMENT THEORIES RELATED

REMUNERATION COMMITTEE
TO COMPENSATION
Best practices suggest that:
Theory Main assumption Practical implications for CEO
compensation Remuneration committee is comprised of a majority of
independent directors
Resource-based Firms can achieve competitive If a CEO’s knowledge, skills and
Theory advantages and superior performance if ability make him a strategic
they build their strategies around resource, pay him accordingly External and independent advisors from professional
resources that are valuable, rare, not  Offering retention incentives for executive remuneration firms be used whenever possible to
easily imitated, and non-substitutable CEO with unique skills
provide advice
Institutional Theory Firms tend to imitate the behavior of their Resist the temptation to mimic the
peers, especially the very successful CEO compensation plans that seem Remuneration committee designs a remuneration package
peers to work for leading firms  Craft the based on a thorough understanding of the company’s
CEO’s package in a way that
matches the firm’s unique situation strategy and goals; package aligns executive incentives
with investor interests
Social network Friendship and other interpersonal When recruiting a new CEO,
Theory relationships among executives influence consider not just the candidate’s
organizational actions and performance past performance, but also the ties Remuneration committee stress tests the remuneration
to other firms package and recommends its well-considered executive
 To avoid losing a well-connected remuneration plan to the board for discussion and final
CEO, keep his compensation
competitive with the market
approval

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EXECUTIVE REMUNERATION CLASSICAL PHRASEOLOGY OF

STRUCTURE EXECUTIVE REMUNERATION IN
CORPORATE GOVERNANCE
Salary “Fat cats”
Bonuses Media term to describe directors with allegedly
excessive remuneration packages
Equity-based pay “Golden handcuffs”
Stock options A term in a director’s remuneration contract granting
significant rewards provided he or she remains with
Restricted stocks the company for a given period
Severance / Buyout / Retirement compensation “Golden hello”
A large one-off payment made to incoming
Pensions and deferred compensation executive director to persuade him or her to join the
company
Severance pay
“Golden parachutes”
Gratuitous payment Large severance payments given to directors on
Perks leaving a company

RED FLAGS FOR DIRECTORS

Are the remuneration committee members

independent?
Do the remuneration committee members have
diverse backgrounds?
Does the remuneration committee retain a
remuneration consultant?
Does the executives’ pay relate to performance?
Are the pay packages stress-tested?
Are all facets of the remuneration regime
disclosed?
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